Secondary Sources: Mission Accomplished?, Fed Watch, Weaker Dollar

Mission Accomplished?:Paul Krugman says it’s too early to declare mission accomplished on the economy. “The complacency now setting in over the state of the economy is both foolish and dangerous. Yes, the Federal Reserve and the Obama administration have pulled us “back from the brink” — the title of a new paper by Christina Romer, who leads the Council of Economic Advisers. She argues convincingly that expansionary policy saved us from a possible replay of the Great Depression. But while not having another depression is a good thing, all indications are that unless the government does much more than is currently planned to help the economy recover, the job market — a market in which there are currently six times as many people seeking work as there are jobs on offer — will remain terrible for years to come.”

Fed Hawkishness:Tim Duy of Fed Watch says recent Fed speak may be undermining the central bank’s stimulative actions. “The data this week has not been supportive of a rapid exit from accommodative policy. Indeed, the opposite could very well be the case. Despite this, Fed officials, albeit to varying degrees, are uniformly signaling that the actions to expand the balance sheet are only temporary and will be reversed absolutely as soon as possible, which only undermines the stimulative potential of those actions. This is definitely not quantitative easing, and uncomfortably harkens back to the fear of inflation that constrained policy at the Bank of Japan. It is interesting that Fed Chairman Ben Bernanke has worked so hard to avoid a repeat of that experience yet appears ready to risk repeating it nonetheless.”

Bank Capital: On the Financial Times Raghuram Rajan argues that more bank capital won’t prevent another crisis. “A number of banks went directly from being well capitalized to default. Part of the problem lies with the accounting, which allows banks to hide a variety of losses, and part with the regulatory incentive to delay recognizing losses. But the bulk of the problem lies with the sheer magnitude of the losses in a systemic crisis such as the current one. The levels of capital required to protect banks fully from failure would be extraordinary. Capital is costly. In good times the market demands very low levels of it from financial intermediaries, in part because euphoria makes losses seem remote. So when regulated financial groups are forced to hold more costly capital than the market requires, they have an incentive to shift activity to unregulated areas – as banks did in setting up structured investment vehicles. More alert regulators could perhaps detect and prevent this, but banks could subvert capital requirements by taking on balance-sheet risk the regulators do not see, or do not penalize adequately with capital requirements. Banks will not be passive in the face of regulatory change. Such arbitrage is one reason excessively high capital requirements are unlikely to hurt financing much in America. Also, the U.S.’s vibrant corporate bond markets can substitute somewhat for over-regulated banks. However, in emerging markets, where banks are the main source of finance, and arbitrage possibilities more limited, capital requirements set too high will reduce intermediation substantially. Emerging markets need to be cautious about accepting significant increases in capital requirements. Better alternatives are to have more uniformity in capital requirements across leveraged financial institutions, to require more “contingent capital”, and to emphasize capital raising as well as preservation when regulators see a crisis coming.”

Weaker Dollar: At Maverecon, Willem Buiter says that a stronger U.S. economy requires a weaker dollar. “Sometimes economics can be helpful even if it does not allow you to make point predictions with any degree of confidence. This is the case, for instance, when it can rule out certain combinations of outcomes for different economic variables as unlikely or even nigh-on impossible. An example of such an unlikely configuration of outcomes is (a) a strong and sustainable recovery of the U.S. economy and (b) a strong (let alone a strengthening) US dollar. A very similar statement can be made about the prospects for a speedy recovery of the U.K. economy.”

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